Volatility Could Be Here to Stay in FX

After August 24 and the volatility that followed, many economists and investment banks thought the time to raise rates was now as further global uncertainty about when the Fed hike could only add to the volatility. On September 17, the Federal Reserve decided not to hike rates bring about a volatile close to the week, which could be beginning to more volatile times. Here’s a look at some of the ways to potentially play the volatility in the FX market and what to look forward to see if volatility is calming down.

Playing the volatility

There are few currencies that do rather well when volatility rises and others that do very poorly in the same environment. On the other hand, there are currencies that do rather well in low volatile markets and others that do poorly in nonvolatile markets. Either way, there are strategies and approaches to take for either type of market. Given the current macroeconomic backdrop of China, oil and commodities, and the uncertainty around the Federal Reserve and the future of the US dollar it’s likely best to have a plan for multiple market environments.

In short, when volatility rises the currencies that are most favored are typically the JPY, USD, & CHF. The reason that the Japanese yen, US dollar, and Swiss franc are so popular is that they are seen as typical safe havens and volatility tends to scare people out of more aggressive trades and into safer investments. Typically, money doesn’t just flow into any asset within these countries but into government debt.

One reason why these countries are specific safe havens when economic storms abound is their national account surplus.

Economies that enjoy a surplus in their current accounts also known as the broadest measure of trade health have seen strength over the last 30 days and times of uncertainty and this could continue. The run-up of accounts with poor current accounts like emerging markets is only attractive when the proverbial skies are blue in the broader economy but as policy tightening by major central banks loom, investors have to be more discriminating as to where they keep their capital and where it may or may not be safe.

Recognizing the slope of volatility

When volatility rises,Equities and bonds it’s typically the fact of multiple asset managers and investors running to the proverbial exit door of their investments at the same time. One unexpected consequence of monetary policy enacted by central banks over the last seven years has been risk seeking capital finding a few popular venues as long as central banks support the larger economy and debt in these economies are getting repaid. However, different actions over the recent months by key players in the global economy like the People’s Bank of China or PBoC’s initial devaluation of their currency, the Yuan sent volatility rising as money left old bets defined safe shores.

It may be helpful to note the volatility is seen as a mean reverting component of markets. However, it’s impossible to state how aggressive were steep the slope higher and volatility will be as people continue to look for ways to exit trades that have gone south. A look at the volatility index or fix back in 2008 after the Lehman bankruptcy shows how quickly money can leave or be forced out of a bad investment. From a global perspective, there is now more dollar denominated debt by non-bank borrowers outside of the United States that we had during the great financial crisis of 2008 2009 to the tune of 50% or $9.2 trillion at the end of 3Q2014.

While it’s a safe bet that Lehman will not go bankrupt again, whatever the cause of the next deleveraging will be, if that $9.2 trillion is to be paid back, the US dollar could continue to strengthen along with other safe haven currencies and perhaps the best way to do that will be to keep an eye on the volatility index